Some random thoughts on game theory, behavioural economics, and human behaviour

Sunday, 11 September 2016

Bolt, Leicester City and Brexit: confidence matters

Standard economic theory takes a very deterministic view of the world in that we solve for a unique equilibrium and expect that to describe what will happen. Game theory offers an alternative perspective in that most games have multiple equilibria and there is no reason to suppose that one of these equilibria is any more likely to describe what will happen than another.

For a long while the existence of multiple equilibria was seen as a 'problem'; surely the objective of economics was to say what would happen and not what might happen? Experimental economics, however, has shown that multiple equilibria are not so much a problem as a reflection on reality. When we observe two seemingly identical groups of people we often find they end up doing very different things. For instance, one group might end up cooperating and other not cooperating.

Another way of looking at the multiple equilibrium problem is to say that small, hidden, seemingly irrelevant things can make a big difference. This view was popularized by Paul Omerod and his book Butterfly Economics. But, the idea that economic events can turn on a knife-edge still seems relatively ignored by a profession that prefers a more straightforward, deterministic view of the world. This is a shame because asking 'what if' questions can be interesting and informative. As a case in point consider the mysterious role of confidence.

A few weeks ago Usain Bolt secured his position as the Greatest. Clearly Bolt is fit and strong. A crucial part in his success, though, is undoubtedly his ability to stay supremely relaxed under pressure. Indeed, a year ago, at the Athletics World Championships in Beijing, the Greatest tag looked under threat. Bolt stumbled through the semi-finals of the 100 metres and Justin Gatlin would surely win gold. Bolt, though, got it right when it mattered. Later, Bolt praised his coach for reminding him that he had nothing to fear. Confidence was the difference between winning and losing. How different things could have been?

As a second example consider the remarkable success of Leicester City in winning the Premier League. Early in the season Leicester played Aston Villa. With 20 minutes to go Aston Villa were cruising, two goals to the good, and playing great football. Then, out of nowhere, Leicester scored three goals and won. This was surely a pivotal moment in the season. Leicester grew in confidence and became unstoppable while Villa fell into despair and hardly won another point for the rest of the season. If Villa had held on to win that game how different would things have been? Confidence can turn an ordinary team into world-beaters or no-hopers.

And finally, let's look at Brexit. Before the referendum on Britain's membership of the EU, just about every economist in the land was predicting that Brexit will harm the UK economy. It surely will. For now, though, large parts of the economy still seem to be trundling along quite nicely. Which has given prominent Brexiters the chance to pour scorn on economists. The missing link is confidence. A majority of people voted for Brexit and so they, presumably, are happy and expecting great things. For the rest of us there is the realisation that we are still a long way from leaving the EU and so things might hold together for a while yet. The vote to leave the EU has not, therefore, caused a sudden and dramatic change of fortunes. Reality will have to kick in at some point but it is consumer and business confidence that will determine when. And there is no predicting when that might be.